Tag Archives: Product

6 Reasons You Should Never Start a Company

Do Not EnterIf you are looking for reasons why you should not start a company, read on!

1. You Could Lose All Your Savings

As a founder, you are investing in your startup. You’re investing your time and your energy; you’re investing yourself. In addition to that, it’s also wise to invest financially in every round if you can. That way when you are raising money and potential investors ask “do you have skin in the game?” you can honestly answer “yes,” and when they ask or “if I say yes, will I be the first investor?” you can honestly answer “no.”

Putting you own money into the company demonstrates commitment. If this requires you to take out a second mortgage or a personal loan, so be it.

If you can’t commit to losing your savings, how can you expect others to put their assets at risk?

2. You Could Lose Other People’s Money

I thought that losing my own money was painful, but that was before I lost other people’s money. Now that’s painful! After all, when investors give you their cash in return for equity in a company you have founded and are leading, they are making a loud and clear statement that they believe in your idea and they believe in you.

Even when you involve your stakeholders and keep shareholders informed of all decisions being made, even when the vast majority of investors bear no hard feelings whatsoever, you spend considerable time looking back at past decisions wondering “what if I had done things differently?”

Bottom line: When you accept other people’s investment dollars, be prepared for the possibility that pain might follow if you fail. That pain might be self-induced, or might come from the investors.

3. You Could Hire the Wrong People

You can’t do it all yourself. You need to hire others to help make the dream come true. If you make the wrong hires, quality will be compromised, too much money will be spent, customer service will go down the tubes, the morale of the “good hires” will suffer, and so on.

4. You Could Lose Control

You like control. After all, the company you are envisioning is “your baby.” You want to control it. When you need to raise cash, you will be telling potential investors how much cash you need and what you plan to do with it. The percent of the company they get for that investment will be up for discussion.

Let’s say you need $500,000. You want to maintain control so you have no intent to sell more than 49% of the company. But the investors value your company at just $800,000. That means if you want their $500,000, you’ll need to sell them 5/8 of the company.

5. You Could Build the Wrong Product

You raise $500,000 from investors and build the “perfect product” for the market. You execute an expensive product launch with a major media presence. And nobody buys the product. The product is a total flop. You either misunderstood the needs of the market, you were too early or too late in the market window, or the competition outsmarted you with an even more impressive product.

6. Your Customer Acquisition Cost Could Be Much Higher than Expected

You did extensive financial planning, and that included modeling the sales process. Only one problem: you think it will cost you $250 to acquire each new customer. What happens if it actually costs you $750 to acquire each one? Now everything in your financial plan falls apart.

In summary

If the above situations scare you, you have an easy way to avoid them: Don’t start a company. Starting a company is not for the pessimist or for the risk-adverse. Nor is starting a company for those who want to get rich quickly and live on a beach.

Starting a company takes courage and optimism.  It requires stubbornness and the ability to rewind and clinically assess mistakes. It tolerates failure but demands success. As crazy as it may sound, if that excites you, you might be about to take your great idea and start your own company!

Let me close by sharing with you three of my favorite quotes:

 “Far better to dare mighty things, to win glorious triumphs, even though checkered by failure, than to rank with those poor spirits who neither enjoy much nor suffer much.  [They] know not victory, nor defeat.”

Theodore Roosevelt

“It is good to have an end to journey toward; but it is the journey that matters, in the end.”

Ursula K. Le Guin

“First, say to yourself what you would be; then do what you have to do.”

Epictetus

ABOUT THE AUTHOR:

Dr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.

If you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money?

How Investors Value Your Startup

Let’s start by discarding two myths:ダイヤモンド査定

  • Investors do not want control of your company! That is the last thing they want. What they do want are (a) handsome returns, and (b) for you to responsibly manage your own company so they don’t have headaches.
  • Investors do not care what past valuations were. On previous rounds, you may have received poor advice and valued your company at, say, $5M, and you found some unfortunate investors to purchase stock at that ridiculous valuation. Oh well, that’s too bad. It has zero effect on what the company is worth today.

What do investors want?

So, what do investors want? And how will they decide what your company is worth? Five main factors influence them:

  1. Is the opportunity exciting? If it isn’t exciting, they won’t bother valuing the company at all.
  2. Is the team qualified to execute on the plan? If not, you just aren’t worth the risk.
  3. Valuation based on current performance. Based on current trailing financials (i.e., what you have already done regarding revenues and profits), and multiples applicable to your specific industry, what is your company worth today?
  4. Valuation at desired time of liquidity. Based on expected performance (i.e., what you say about expected revenues and profits in your plan), and multiples applicable to your specific industry, what will your company be worth in the future? See below and blog on Determining Future Valuation.
  5. At what stage is the company? The biggest hurdles a startup has are:
    • building a product
    • getting the first revenue
    • demonstrating a repeatable sales model
    • demonstrating sustainable growth without continuing to invest external cash.

As you jump each of these hurdles successfully, the risk of total failure decreases significantly. Investors have their own rules of thumb about how that “risk of total failure” affects valuation. Here are my rules of thumb:

  • If you have not yet built your product, assume valuations will be no more than 25% of the valuations calculated using the techniques shown below.
  • If you have built your product but have not yet received revenue, assume valuations will be no more than 50% of the valuations calculated using the techniques shown below.
  • If you have built your product, started receiving revenue, but have not yet demonstrated a repeatable sales model, assume valuations will be no more than 75% of the valuations calculated using the techniques shown below.
  • If you have demonstrated a repeatable sales model and are looking for investments to “ramp up,” then the following techniques for valuation are applicable.

What To Do With Future Valuation?

Let’s talk a bit more about item 4 above. What will investors do with that future valuation once it is computed? They certainly won’t use it for today’s valuation. What they will do is use it to determine what value the company needs to have today so they can receive an acceptable return on their investment. Assuming that FV is the computed future valuation of the company at the time of liquidity, IRR is the investor’s desired rate of return and n is the number of years between now and the liquidity event, the calculation goes as follows:

Current Value of Company = FV / (1 + IRR)n

So, for example, let’s say the FV is determined to be $15M (using the techniques of the blog, Determining Future Valuation), and the investors desire a 50% IRR (not unreasonable considering the degree of risk) over 5 years. Plugging those numbers into the above formula, we get:

Current Value of Company = 15M / (1 + .5)5 = $1.98M

So, if you are looking for those investors to invest $500K now, expect them to ask for 25% of the company (because $500K is 25% of $1.98M); if you are looking for those investors to invest $250K now, expect them to ask for 12.5% of the company. And so on. But this applies only after you have demonstrated a repeatable sales model.

Now you need to factor in the risks described above. If your company is:

  • Pre-product, valuations decrease by around 75%. So continuing with the above example, the company now has a current valuation of around $500K. So, if you are looking for those investors to invest $500K now, expect them to ask for 100% of the company (obviously not a good idea); if you are looking for those investors to invest $250K now, expect them to ask for 50% of the company.
  • Pre-revenue, valuations decrease by around 50%. Continuing with the above example, the company now has a current valuation of around $1M. So, if you are looking for those investors to invest $500K now, expect them to ask for 50% of the company; if you are looking for those investors to invest $250K now, expect them to ask for 25% of the company. And so on.
  • Pre-repeatable sales, valuations decrease by around 25%. Continuing with the above example, the company now has a current valuation of around $1.5M. So, if you are looking for those investors to invest $500K now, expect them to ask for 33% of the company; if you are looking for those investors to invest $250K now, expect them to ask for 16.6% of the company. And so on.

None of the above is motivated by greed or a desire for control; it is pure economics. Investors want (and deserve) a fair return for their investment.

Of course many other factors come into play including experience, negotiation skills, degree of desperation to obtain cash, and availability of competition for deals (for the investor) and investors (for the entrepreneur).

Alan DavisDavis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and the author of six books.